## Taming the Currency Hype

_IMF Blog, August 21, 2019_

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**Canonical URL:** [Taming the Currency Hype](https://www.imf.org/en/blogs/articles/2019/08/21/blog-taming-the-currency-hype)

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## Bibliographic details
- Authors: Gustavo Adler, Luis Cubeddu, Gita Gopinath
- Published: August 21, 2019

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### Context and summary
- Authors: Gustavo Adler, Luis Cubeddu, Gita Gopinath
- Date: August 21, 2019
- Main point: Escalating trade tensions and policy responses have weighed on global growth forecasts for 2019-20; exchange rate movements and monetary easing cannot be relied on to correct large trade imbalances, and tariff- or currency-targeting measures are likely counterproductive. Durable solutions require macroeconomic and structural policies by both deficit and surplus countries and cooperation to address trade disputes.

### Exchange rates can’t do it all
- Monetary easing stimulates domestic demand and can boost demand for other countries’ goods, but also weakens the exchange rate, producing expenditure switching.
- Key empirical findings (from the 2019 External Sector Report):
  - Expenditure switching effects are generally small, especially within a 12-month period.
  - A 10 percent depreciation (vis-à-vis all currencies) improves a country’s trade balance by about 0.3 percent of GDP in the near term, on average, with most effects coming through a contraction of imports.
  - Over a span of three years, a 10 percent depreciation leads, on average, to a 1.2 percent of GDP improvement in the trade balance.
- Reasons for muted effects:
  - Trade is largely invoiced in dollars, so export volumes tend to respond little to exchange rates in the short run.
  - For the United States, the muted impact reflects a weak response of imports.
- Conclusion: Exchange rates facilitate durable external adjustment but the expenditure switching effect of currency weakening and its negative impact on trading partners should not be overplayed.

### Counterproductive policy options
- Tariffs:
  - Tariffs and exchange rates work differently; a 10 percent tariff does not necessarily offset a 10 percent more appreciated exchange rate.
  - Example: Since early 2018, the average US tariff on goods imported from China increased by about 10 percentage points and would increase by another 5 percentage points if recently announced plans are carried out.
  - Meanwhile, the renminbi has depreciated by about 10 percent relative to the dollar, largely as a result of these trade actions and associated uncertainties.
  - In practice, US importers and consumers are bearing the burden of tariffs because dollar invoicing has minimized the impact of the stronger dollar on the dollar prices Chinese exporters receive.
  - Higher bilateral tariffs are unlikely to reduce aggregate trade imbalances because they mainly divert trade to other countries.
  - Negative consequences: harm to domestic and global growth by sapping business confidence and investment, disrupting global supply chains, and raising costs for producers and consumers.
- Direct attempts to weaken the currency:
  - Proposals to buy foreign currencies or tax inflows to offset other countries’ policies are cumbersome and likely ineffective given the depth of reserve currency markets (dollar, euro).
  - Such measures have negative implications for the orderly working of the international monetary system.
- Risks of retaliation:
  - Policies of either kind will likely encourage retaliation, undoing any benefit for a single country and making all nations worse off.
  - Such actions may also possibly violate international obligations such as those to the World Trade Organization.

### Constructive, shared solutions
- Broad assessment:
  - External positions are not grossly misaligned; external imbalances are down sharply from the peaks seen during the global financial crisis.
  - The dollar was only moderately overvalued in 2018, contrasting with the mid-1980s situation that prompted the Plaza Accord.
- Policy recommendations:
  - Both deficit and surplus countries should tackle underlying macroeconomic and structural sources of imbalances rather than adopt ineffective or counterproductive measures such as tariffs.
  - For deficit countries (examples: the United States and the United Kingdom):
    - Reduce budget deficits without sacrificing growth.
    - Strengthen competitiveness of export industries, including investing more in skills of workers and encouraging old-age saving.
  - For surplus countries (examples: Germany and Korea):
    - Use fiscal policy where possible to invest more in infrastructure.
    - Adopt reforms that encourage private investment, such as supporting innovation through tax incentives for research and development and lowering barriers to entry in business services and regulated professions.
  - For China (external position broadly in line with fundamentals in 2018):
    - Further structural reforms to ensure lasting external rebalancing and to address vulnerabilities from high levels of private and public debt (see the 2019 Article IV consultation for China).
    - Steps include reforming state-owned enterprises, enhancing the social safety net, opening up more sectors to private and foreign competition, and removing impediments to trade.
- Multilateral responsibilities:
  - Surplus and deficit countries share responsibility for a stronger, more balanced global economy.
  - Durable solutions should include addressing concerns about export subsidies and weak intellectual property protection and modernizing the international trade system in areas such as services and e-commerce.
  - Currencies are neither the hammer nor the nail when confronting problems like rising inequality and sluggish growth.

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## References

- [Português](https://www.imf.org/pt/News/Articles/2019/08/22/blog-taming-the-currency-hype?sc_mode=1)
- [forecasts](https://www.imf.org/en/Publications/WEO/Issues/2019/07/18/WEOupdateJuly2019)
- [2019 External Sector Report](https://www.imf.org/en/Publications/ESR/Issues/2019/07/03/2019-external-sector-report)
- [https://www.imf.org/wp-content/uploads/2019/08/eng-aug-19-currency4.png](https://www.imf.org/wp-content/uploads/2019/08/eng-aug-19-currency4.png)
- [https://www.imf.org/wp-content/uploads/2019/08/Chart-1-Currency-Blog.jpg](https://www.imf.org/wp-content/uploads/2019/08/Chart-1-Currency-Blog.jpg)
- [earlier blog](https://blogs.imf.org/2019/05/23/the-impact-of-us-china-trade-tensions/)
- [https://www.imf.org/wp-content/uploads/2019/08/eng-august-15-currency2-2.png](https://www.imf.org/wp-content/uploads/2019/08/eng-august-15-currency2-2.png)
- [https://www.imf.org/wp-content/uploads/2019/08/eng-august-15-currency3-2.png](https://www.imf.org/wp-content/uploads/2019/08/eng-august-15-currency3-2.png)
- [2019 Article IV consultation for China](https://www.imf.org/en/Publications/CR/Issues/2019/08/08/Peoples-Republic-of-China-2019-Article-IV-Consultation-Press-Release-Staff-Report-Staff-48576)

_Source: https://www.imf.org/en/blogs/articles/2019/08/21/blog-taming-the-currency-hype_